A ‘Buy-Side’ Attorney Comments on Merger Requirements, Special Access

Special access rates have long been a key concern of both competitive service providers and their enterprise customers. And when SBC and Verizon announced their respective intentions to buy AT&T and MCI, carriers that rely on special access went on alert given that the IXCs traditionally have offered far lower wholesale pricing for access than the RBOCs.

Of course, the conditions set as part of the FCC’s approval yesterday of the SBC-AT&T and Verizon-MCI combinations address special access, among other competitive issues. But many believe they don’t go far enough.

Below is a Q&A xchange Editor in Chief Paula Bernier did today with attorney Colleen Boothby of Levine, Blaszak, Block & Boothby, which represents the enterprise customers that buy communications services from our industry, discussing the merger requirements, special access and where she thinks the FCC went wrong.

XC: What are the key issues addressed in the FCC’s conditions for these mergers?

CB: There’s a special access rate freeze that’s in place for two-and-a-half years. There are basically five areas. There’s naked DSL, backbone peering, net neutrality, special access and some UNE stuff. I think if you look at Copps’ separate statement – that’s how he breaks it down. That’s the best way to look at it.

XC: Let’s take the special access thing first. So did the FCC in its merger requirements answer the special access concerns that the CLECs and their customers have been waiting for?

CB: They’ve imposed this rate freeze, and it’s a rate freeze on the prices AT&T and MCI charge in region as well the prices SBC and Verizon charge in their tariffs.

We participated in the final weeks as part of a coalition of CLECs and IXCs and Qwest, and I think the CLECs were free to pursue other issues as well that weren’t within the scope of the coalition. So I don’t want to speak for CLECs when they had other issues they were pursuing.

[In approving the mergers, the FCC] went a ways toward [addressing CLEC/enterprise interests]. It did freeze the rates. What the coalition I participated in wanted was some rate reduction. The idea was to lower SBC’s and Verizon’s rates to preserve the price point that MCI and AT&T introduced into the marketplace, which is lower than the SBC and Verizon rates that other CLECs were qualified for.

By freezing AT&T’s and MCI’s rates so that they still stay out there in the marketplace for CLECs and IXCs to buy -- that might get them the dollar level that they needed. But to freeze SBC’s and Verizon’s rates when they are so outrageously high is not going far enough.

XC: Eschelon and XO along with Broadview, BridgeCom, Conversent, NuVox, TDS Metrocom and Xspedius this fall asked the FCC to require local wholesale prices to reflect pre-merger conditions, suggesting special access rates be reinitialized at 11.25 percent, or determined by commercial negotiations with a requirement that “baseball arbitration” be used if the negotiations fail; ensure UNEs and freeze rates; recalculate the Triennial Review Wire Center Test by eliminating AT&T and MCI as fiber-based colocators; give AT&T and MCI customers the right to exit contracts; and eliminate the DS1 loop and transport caps (since they were based on the availability of competitive facilities, which will be greatly reduced when AT&T and MCI cease to be independent competitors). Were any of these requests met by the FCC terms of the mergers?

CB: They have to redo the rate center list to reflect AT&T’s and MCI’s exiting. So basically the idea is if you’ve got a rate center on the list as being competitive, based on AT&T’s or MCI’s presence, then they’ve got to recalculate that list and exclude fiber-based colo arrangements of AT&T in the SBC region and MCI in the Verizon region.

... Conceptually, think of it this way, if they looked at a CO and said “there’s competition at that CO because AT&T and MCI are there so that tells me CLECs don’t need UNEs for that CO because they can go in competitively – like, AT&T and MCI did,” then the order says “ok, wait a minute, AT&T and MCI are no longer competitors, they’re merged, so we’ve got to take that central office off the list.”

XC: I’m told the IXCs traditionally have offered far lower wholesale pricing for access than the RBOCs. XO Communications CEO Carl Grivner says AT&T and MCI almost always come out as No. 1 and 2 bidders on- and off-network. But Grivner says that AT&T and MCI now are limiting to 24 months their contracts with businesses, which could indicate a possible rate increase in the not-too-distant future. So how do the terms of the mergers tie into that discussion?

CB: OK, let’s back up. MCI and AT&T, because of their traffic volumes and because of their ability to optimize and use DS3s or OCs instead of just DS1s, they were able to introduce cheaper price points into the market for special access services. Special access is what BOCs provide to IXCs and CLECs and end users. What AT&T and MCI provide is something they call local private-line services. It is renamed. But we’re basically talking about DS1s and DS3s.

So AT&T and MCI -- by virtue of having a local of traffic on their networks and being able to aggregate it to optimize the facilities they buy because they can trade up to higher volume, lower unit cost facilities -- could achieve these prices that other folks with lower traffic volumes and different distributions of demand couldn’t achieve. So the issue was “well, how do we keep those AT&T and MCI price points in the marketplace…?”

And it’s clear what [the FCC] is intending to do – or at least what Commission Copps’ separate statement suggests – in that two-and-a-half year period, and certainly what they should do in that two-and-a-half year period, is bring home that special access investigation. They’ve got this open investigation of the rules that apply to SBC and Verizon and all the other BOCs that give them a lot of flexibility in pricing because the commission assumed when they adopted the rules that competition was going to emerge just any minute! And that should be a pretty familiar refrain. We’ve had about four or five years of FCC decisions saying “we can deregulate now because competition is going to show up just any minute now! Any minute we’re just going to turn that corner and the market will be fully competitive!” And it hasn’t happened.

So they started this rulemaking with a court appeal hanging over their head. Basically, the court – [in response to] a mandamus appeal that AT&T filed with the DC Circuit – pushed them into starting a proceeding to look at its rules and the reason they started this proceeding is that enough people were saying “You’re deregulating because you think there’s a lot of potential for competition. Well it hasn’t shown up, and what we have is a lot of deregulated monopolists and prices are going through the roof. So stop that.”

That proceeding is still pending. And, hopefully, the two-and-a-half years will be long enough for the commission to bring that proceeding home and change the rules.

At current levels, SBC is earning in the 70 percent rate of return, and that’s not EBITDA, that’s earnings after interest, taxes, depreciation and amortization. And that is a fully loaded return – in the 70 percent level. BellSouth is earning 81.9 percent. So the prices are too high and they’ve frozen them so they can’t keep going up, which they’ve done steadily. They’re still too high, but they have this open proceeding.

XC: Let’s go through these other FCC requirements on the mergers one by one. On the naked DSL, what are your thoughts on the terms the FCC is requiring?

CB: It’s a plus for CLECs with enterprise customers. What they want DSL for is a cheaper alternative to T1s at locations where they need lower volumes than T1. And DSL is a perfect service for a lot of enterprise customers. Enterprise customers have a surprisingly big number of lower-volume locations. They’re not just people who need OC192s in their headquarters in the center of an urban corridor in a big city. Enterprise customers, contrary to what a lot of public policy people think, need a lot of low-volume locations. DSL is a great service for those low-volume locations.

Naked DSL is more of a CLEC issue because the BOCs currently provide DSL only to information service providers and not end users in their tariffs. End users cannot buy DSL. What we think of as naked DSL is a DSL circuit from point A to point B with no Internet access and no VoIP and nothing on it except for that plain vanilla transmission line. And that is not what naked DSL means. Naked DSL means they will sell you the DSL in their tariff, which is Internet access, but you don’t need to be a voice customer to get it.

Whether that’s good for CLECs – you’ll have to talk to the CLECs. But for enterprise customers, what they’re looking for is even fewer clothes on the DSL.

XC: What are the network neutrality rules the FCC mentions in its release about the mergers and why is that meaningful?

CB: They put out these principles, these net neutrality principles; they’re also very much a live issue on the Hill. There are a lot of tech companies and Web content providers who are pushing that neutrality on the Hill as part of any rewrite of the Communications Act. We view it as a way to get the protections against content-based discrimination that the commission used to have in its Computer 2 and 3 rules. But it’s just not fashionable to say Computer 2 and 3 anymore. If net neutrality can produce the same effect, then that’s terrific.

[Net neutrality] is about the BOCs not interfering with where an end user goes – content and applications. So they can’t block your access to a Web site, and they can’t choke off [particular services or applications].

Some services are bandwidth hogs. But if your rules are neutral as to content, so if I buy more bandwidth I get more bandwidth, that’s fine. But if your rule is “I’ll choke off your transmission line when you’re not using my VoIP service,” that’s bad. Net neutrality is about preventing the BOCs from degrading service or modifying service based on the end-user content and applications.

XC: So, the FCC adopted network neutrality rules when and as part of what effort?

CB: In principle, as part of the Broadband Wireline Internet Access Order that they adopted earlier this summer. That’s the order that deregulated the BOCs’ DSL Internet access so that it would supposedly be on the same level playing field as cable modem – they would both be deregulated.

At the same time they adopted that order they adopted these principles – net neutrality principles. And everybody sort of scratched their heads and said “What is a principle. What does that mean – a principle? Is it enforceable?” And there was a lot of “mumble, mumble, mumble – these are principles and we will look to them as we enforce our rules.” So they weren’t rules.

What the press release says is that these net neutrality principles are now going to be enforceable conditions of these mergers.

The whole drill is that merged parties come in and they commit to things. It’s their voluntary commitment. And what the commission says is “OK, I’m merely accepting that commitment and making that an enforceable condition of the grant of authority.”

XC: So, are you saying that doesn’t necessarily mean compliance?

CB: No, it does. But in theory it’s coming from the applicants and not the commission. So the reality is they knew what they needed to commit to if they wanted to get the order approved. So they committed for two years to comport with that policy statement. And what the commission then does in the statement is then say “OK, I’m going to take you at your word. These commitments you’re making are hereby enforceable conditions.”

XC: The FCC also said these companies need to “promise not to block Internet traffic from accessing VoIP services and exchanging videos”? Isn’t that the same thing as net neutrality?

CB: Yeah. That you can’t peer into the content of the end user and say “I’m going to handle the traffic differently based on the content.”

XC: So, overall, what are your thoughts about the FCC’s conditions for the SBC-AT&T and Verizon-MCI mergers?

CB: I need to see the text of the order because there are some ambiguities in the press release that make it hard to evaluate. It’s better than nothing. But given the facts on the record, I think the commission should have – could have – gone much farther in protecting competition and protecting consumers.

The special access prices are way too high. That’s a huge competitive weapon – an enormous competitive weapon – because IXCs and CLECs and wireless carriers rely very heavily on special access, and if it is overpriced you’ve got price squeeze issues, it suppresses demand, customers are paying too much. It really distorts the whole marketplace.

XC: Are the FCC’s requirements of the mergers different than what the DOJ wanted?

CB: Well DOJ can’t do rate regulation. But the DOJ order goes on and on and on at great length about how noncompetitive the special access market is. In a way, the remedy in the DOJ order is inconsistent with the market analysis in their complaint.

What the DOJ does is they file a complaint saying this market is or is not competitive enough for the merger to happen. And they simultaneously file a settlement saying “here is what the parties need to do to make it possible for me to OK the merger.” So there are two documents. And that paperwork is now before the court and there’s a 60-day period for parties to comment on it.

In the complaint side they have a very good discussion of special access where they explain how noncompetitive that marketplace is. In the settlement side, their conditions just go to divesture because they’re not the agency that gets to do rate regulation – that’s not their job, that’s the FCC’s job.

So if I were an FCC commissioner reading DOJ’s conclusions – factual findings about the state of competition in the special access market – I would be leaping into action to do something about special access prices. Because at this point I don’t think there’s any controversy remaining about whether that market is non-competition.

XC: How do you think the mergers ultimately will affect the market?

CB: Obviously we’re looking at a less competitive market in terms of the number of competitors and the number of competitive choices the end users have. It’s a real fork in the road.

If SBC decides to compete vigorously with Verizon that would be a good thing. My concern is that they won’t, that SBC and Verizon will not compete vigorously. Maybe they will for a year or two, the AT&T and MCI mindsets in both companies will drive them to continue competing – just the sheer inertia of those two companies who are used to squaring off for enterprise business. Beyond that timeline, will the Bellhead mindset kick in that is very geographically limited and non-competitive?

Colleen Boothby is a partner in the firm of Levine, Blaszak, Block & Boothby, LLP, where she provides counsel and strategic advice on a wide variety of regulatory, business, and litigation matters to enterprise customers and providers of communications and information technology products and services.

Levine, Blaszak, Block & Boothby LLP www.lb3law.com

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